Avoiding Missteps: Create a Plan for Exiting Your Cannabis Business, Says CPA

Welcome to our Cannabis Opinion section. Remember opinions expressed do not necessarily reflect that of Redheaded Blackbelt nor have we checked the letters for accuracy. 

I stepped on a rattlesnake once. It was 30 years ago in Piercy and remains a vivid memory. My body still reacts if the thought even crosses my mind. I’ve never covered that much distance so quickly before or since. There is something built into our DNA that recognizes, in a split second, what has just happened. I think they call this a misstep.

All missteps are not created equal. Some, like the snake, provide immediate feedback. Others, like hypothesis testing or research and development might involve a series of missteps, in a controlled environment, which in the aggregate advance a product or process. Other missteps, such as choosing the wrong business partner, might result in business failure or substantial financial losses far down the road. Missteps are the result of decisions and decisions have consequences.

In business and life, we make our plans. We work towards goals. But life tends to happen. Man plans and God laughs. Sometimes a misstep, series of missteps, or confluence of events and circumstances beyond our control force our hand. Maybe time and age catch up and it’s time to sell. We could lose a business or life partner, the absence of whom irreparably alters our ability to move forward. If we have not planned, it is at this point that our missteps become apparent or, often, demand from us that we finally deal with what we have known and ignored for years, or decades, would eventually come back to bite us. We face an exit.

I have been through a couple of business exits of my own and helped many clients over the years transition their business to new owners. The most successful transitions I’ve seen are the result of deliberate succession planning. The same is true for an estate. As a rule of thumb, I’d say that a good succession or exit plan for a business is about a 5-year process. A bad succession plan looks something like an internet date gone horribly wrong, with similar results. Perceived value, by one or both parties, may simply not align and your improvised exit strategy may have you crawling out a bathroom window.

At the heart of a business exit is the concept and calculation of value. It has always been there because it is central to the purpose of business itself. In an efficient market, like the publicly traded exchanges, value is constantly reflected in the share price of a stock. Granted this is simplified and open for debate but let’s say this is generally true. Most cannabusinesses are closely held. The market for them is less efficient and therefore value isn’t a readily available metric. Value then must be calculated.

Business valuation is a specialized field. It is not my area of expertise but I have developed a working knowledge of the process over the years as I have dealt with many valuations in estate administration, divorce, arm’s length sales, and other scenarios which require valuation. It is both art and science. It requires financial analysis and judgement by the Valuation Analyst.

A business valuation uses historical financial results as the basis for analysis. Then, depending on the method employed, an analyst may apply an industry specific factor or multiple to a target number such as EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) or Seller’s Discretionary Earnings to arrive at an ultimate value.

When it comes time to exit and make a value determination it is important that good records are available. There will likely be bankers, attorneys, CPA’s, one or more generations of family owners, unrelated party shareholders or members, brokers, insurance agents and others involved. This is where the prior implementation of proper cannabis specific accounting and historical tax strategy employed will meet a litmus test. Specifically, it is here that short-term focused efforts to beat 280e or manipulate earnings, coupled with poor accounting records, will potentially create a discount to the value of a subject business.

Conversely, I believe that brand development, rock solid accounting, permanent audit trails and consistent GAAP reporting and cost accounting will create a premium. An unofficial estimate of this premium from one of the premier subject matter experts in the field is 10-15%. It is hard to say what a discount might look like for bad accounting records but I would venture to guess that it could be twice the amount of the premium attached for sound books. Bad records, tax code non-compliance and the inevitable accompanying liabilities will narrow the field of potential buyers and you the seller will have to negotiate from a position of weakness. After all of your years of hard work do you want your exit to be an exclamation point or a lingering regret?

Loren Harwood, CEO/CPA

Orcal Coastal CPA, LLC